ACTG 3110 Chapter 5 - The Balance Sheet and the Statement of Cash Flows

Overview Balance Sheet –Time period –What it represents (resources and claims) –Uses - Liquidity Solvency Financial Flexibility –Limitations Generally figures are based on historical cost Does not represent net worth of company Omits valuable resources (people)

Balance Sheet Assets - –Definition - Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. –Listed in order of liquidity –Generally valued at cost; some items valued at fair market value or net realizable value –Designated as current or noncurrent

Balance Sheet –Current - expected to be used up or converted to cash within one year or the operating cycle, whichever is longer –Operating cycle – time to take cash and buy inventory and sell inventory and collect the money from the sale –Examples – cash, accounts receivable, inventory, marketable securities, notes receivable, prepaid expenses –Noncurrent assets - everything else Long-term Investments Property, plant and equipment Intangible assets Other assets

Balance Sheet Liabilities –Definition: Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. –Listed in order of payment –Designated as current and long-term depending on when to be paid

Balance Sheet Liabilities –Current liabilities often valued at maturity value Must mature within one year or the operating cycle, whichever is longer Management must intend to eliminate them through the use of existing current assets or the creation of other current liabilities Working capital = current assets – current liabilities Examples: Accounts payable, Short-term notes payable, interest payable, income taxes payable –Long-term - often valued at net present value Examples: Bonds payable, Mortgage payable, Long-term lease obligations, Long-term notes payable, deferred income taxes Contingencies

Balance Sheet Owner’s Equity –Represents net assets (Assets-liabilities) –Listed in order of permanence –Contributed capital Capital stock (par or stated value) Additional paid-in capital (Excess of market value over par/stated value) Different classes of capital (preferred generally listed first)

Balance Sheet Retained Earnings –Earnings kept in the business and not paid out since the firm’s inception –Negative amounts are called “deficits”. Accumulated Other Comprehensive Income Treasury Stock –Repurchase of company’s own stock –Shown as a negative amount in stockholders’ equity classification

Formats Account form Report form International differences –Formats –Terminology

Additional Information Reported Contingencies Accounting Policies Contractual Situations Fair values Notes to financial statements Supporting Schedules

Statement of Cash Flows Why do we have a statement of cash flows? What are the purposes? Is “Cash” necessary for survival? Solvency is one of the main objectives of a business Brief History

Cash Cash and cash equivalents Cash inflows Cash outflows Subtotal for net inflows Cash flows generally do not correspond to the general ledger General ledger is on the accrual basis

Classification Operating activities –Basically day-to-day transactions –Generally income statement items Investing activities –Generally involve long-term assets Financing activities –Generally notes payable, long-term liabilities, and stockholders’ equity transactions

Operating Activities Indirect Method Starts with Net income on the accrual basis and determines cash flows from operating activities Net Income Adjustments: –Add back noncash expenses –Add/subtract changes in current assets and liabs –Add losses/subtract gains YIELDS THE SAME NET CASH FLOWS AS THE DIRECT METHOD

Investing Activities Inflows: –Sell property, plant and equipment –Sell long-term investments –Receive principal on note receivable Outflows: –Purchase long-term investments –Purchase property, plant, and equipment –Lend money

Financing Activities Inflows: –Issue stock –Issue bonds –Receive notes payable Outflows: –Pay back principal on notes payable –Purchase treasury stock –Pay cash dividends

Non-Cash Activities Activities which do not involve cash but which affect our investing and financing accounts Listed on a separate attachment Examples: –Purchase a building by issuing a note payable –Retire bonds by issuing common stock

Usefulness of the Statement of Cash Flows Financial liquidity –Net cash provided by operating activities/average current liabilities = current cash debt coverage –Ratio of 1:1 is good Financial flexibility –Net cash provided by operating activities/average total liabilities = cash debt coverage ratio –The higher the ratio, the better Free cash flow –Net cash provided by operating activities – capital expenditures – dividends = free cash flow –The higher the amount, the better